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Europe to open lower after another US inspired sell-off

It would appear that the brief respite for stocks seen in the middle of the week turned out to be the eye of the storm as once again rising bond yields prompted a further bout of selling across the board, not only in the US last night but in Asia again this morning.

Concerns about rising interest rates weren’t helped by an unexpectedly hawkish inflation report from the Bank of England yesterday, while the latest Chinese trade data suggested that the Chinese economy appeared to be ticking along nicely, even if the trade surplus did shrink quite sharply as a result of a big jump in imports.

US weekly jobless claims also dropped sharply to 221k, once again reinforcing the tightness of the US labour market which in turn could well put further upward pressure on wages in the months ahead.

As a result US bond yields started edging higher again with the 10 year yield once again looking to retest the 2.9% level and a four year high, with the 3% level now a very realistic probability. A US government shutdown which started at midnight isn’t helping sentiment either.

While this continued optimism about how the US economy is likely to perform is a good thing, for US stocks whose valuations are still at elevated levels, they may not be particularly good news given that yield differentials are no longer working in their favour, unlike in Europe where dividend yields are still higher than the yields on government debt.

This may help explain why the Dow and S&P500 once again closed sharply lower again, with the Dow losing over 1,000 points, and in the process closing in correction territory, while the VIX once again popped higher.

As a result of last night’s sell-off in the US, and this morning’s weakness in Asia, European markets look set to follow suit this morning and open lower, while the Nikkei 225 also slid into correction territory as it tested its long term 200 day moving average.

Despite all of this gold prices, which normally rise on the back of rising uncertainty, have remained steady and are currently languishing near two week lows.

The Bank of England caught the markets unawares yesterday by the hawkish nature of their message about the prospect for interest rates, in the months ahead. The tone appears to suggest that they may well be more worried about the outlook for inflation than they are perhaps letting on, or they are becoming less tolerant of it, given recent price data.

The recent strength of input prices may well have influenced their thinking in this regard. The rise in oil and broader commodity prices certainly has the potential to make current levels of CPI much stickier than they should be, and the bank does appear to be less certain about how quickly inflation is expected to fall than they were in November, when they expressed the view that inflation had peaked.

On a more positive note the bank upgraded its GDP forecast for this year to 1.8%, while expressing confidence that wages would start to head up towards the 3% level by the end of this year, as a tighter labour market starts to push wages higher. We’ve already started to see evidence of that already with minimum wage increases starting to come through, and if the US is any guide we could see further gains in the months ahead.

On the data front we have the latest manufacturing and industrial production data for December which is expected to wind up a strong end to Q4 for this particular sector which has been firing on all cylinders in recent months.

Manufacturing is expected to rise 0.3%, though industrial production is predicted to show a decline of 0.9%, due to a drop in mining output. The latest GDP estimate from NIESR is expected to show that the UK economy grew 0.5% in the three months to January.

EURUSD – while we remain below the 1.2320 area we remain susceptible to further losses towards the 1.2160 area. We need to get back above 1.2330 to stabilise. Resistance remains back at the recent highs last week just above the 1.2500 area.

GBPUSD – pushed up to 1.4065 yesterday before drifting back down again, slipping back below the 1.3970 area. The main support area remains back at the lows this week at 1.3830, and this needs to hold to prevent a move back to the 1.3660 area.

EURGBP – had another attempt at the downside yesterday before finding support at the 0.8730 area. The broader support remains below that at the 0.8680 area, but for now remains stuck in a range, the top of which is currently at the 0.8910 level.

USDJPY – continues to find a degree of support down the 108.40 area but does seem vulnerable to further losses towards 107.20 on a break below here. Resistance remains up near the 110.2 area in the short term.

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